Treasury Secretary Henry Paulson also rattled the market's cage after he said the collapse of Bear Stearns highlights the government’s need to strengthen and clarify rules governing the financial sector – from commercial banks to investment houses.

Notably, the decision to allow investment banks access to the Federal Reserve’s discount window should be reviewed after six months, Paulson said in a speech before the U.S. Chamber of Commerce.

Paulson also said that the government shouldn't interfere with an "inevitable" drop in home prices but rather work to contain the impact on the broader economy.

"A correction was inevitable and the sooner we work through it, with a minimum of disorder, the sooner we will see home values stabilize, more buyers return to the housing market, and housing will again contribute to economic growth," Paulson said in prepared remarks.

Financials were one of the day's biggest decliners, with the S&P 500 financial index down more than 3 percent.

Citigroup led Dow decliners after Oppenheimer slashed its earnings estimates on the four largest U.S. banks, citing the likelihood of more write-downs. The other three were: JPMorgan , Bank of America and Wachovia .

There is "no clear end in sight" to downward pressure on bank earnings, Oppenheimer analyst Meredith Whitney wrote in a note accompanying the decision.

Goldman Sachs also cut its earnings estimate for Bank of America amid continued weakness in the credit markets, which could force additional write-downs, analyst Brian Foran said. He estimates the bank will take a $3 billion write-down in the first quarter.

Asset writedowns and disruption to revenue stemming from the global credit turmoil could put Deutsche Bank's profit goal for this year at risk, the bank said in its annual report, sending its shares lower in Europe.

Also in financials, the saga of Bear Stearns continued as two U.S. pension funds have asked a Delaware court for an emergency order to delay JPMorgan from moving forward with its takeover plans.

Meanwhile, more than 100 JPMorgan staffers moved into Bear Stearns' New York offices to begin the integration process, and more than 100 protesters from a homeowners' group demonstrated in the lobby of Bear Stearns, saying the Fed should be helping out on Main Street, not Wall Street.

Still, there was some optimism in the market.

David Bianco, chief equity strategist at UBS, said his team expects to see 20 percent growth in the S&P 500 by year end amid a lot of upside surprises in earnings from from nonfinancial companies.

That was an encouraging forecast, particularly after this morning's report in the Wall Street Journal that we may be in a lost decades for stocks, with the inflation-adjusted return on an average investment in the S&P 500 at the same level as it was nine years ago.

Brian Rauscher, director of portfolio strategy at Brown Brothers Harriman told CNBC that, he expects S&P 500 operating earnings per share, excluding financials and homebuilders, to be up about 9 to 11 percent. Including those battered categories, S&P earnings will likely be down about 12 percent, he said. (Read the full Market Insider post.)

Shares of Sprint and Clearwire advanced amid reports that the companies are in talks with the two biggest U.S. cable operators to form a nationwide wireless network. The $3 billion joint venture would be funded in part by a $1 billion contribution from Comcast and $500 million from Time Warner.

Elsewhere in tech land, Jabil Circuit shares skidded after the electronics-parts maker said late Tuesday that revenue in the second half will be consistent with the first half, which is lower than many analysts had expected. JPMorgan lowered its rating on the stock to "underweight" from "overweight."

Shares of Oracle slipped ahead of the software maker's earnings, due out after the closing bell.

AMR , parent of American Airlines, said it has voluntarily canceled nearly 10 percent of its flights Wednesday to check wiring in its MD-80 planes. The move, which affects 200 flights, is part of new FAA requirements following alleged inspection lapses at Southwest Airlines that resulted in a proposed $10.2 million fine.